Company directors face tougher scrutiny over how they recognise and account for climate change risk.
The warnings have been given. Australian Prudential Regulation Authority (APRA) executive board member Geoff Summerhayes said in February 2017 that climate-related financial risks were firmly in sight, and in June 2018 Australian Securities and Investments Commission (ASIC) commissioner John Price said climate change risk was a corporate governance issue.
The regulators have made it clear that companies will be expected to provide disclosure on climate risk in line with the generally accepted principles of corporate governance.
Auditors, too, will need to be wary, as they sign off on financial statements that, to the best of their knowledge, do not contradict directors’ statements.
It is a matter of directors’ duties on which Sarah Barker, Special Counsel at Minter Ellison, has written extensively. She says that in order to exercise due care and diligence, it is not about what a director knows, but what he or she ought to know. The fiction that climate risk is an environmental issue that has nothing to do with generating revenue is dead in a world where the associated policy debate rages.
“The point is that politics is becoming less and less relevant because of a market shift toward material and financial risk, rather than environmental risk,” says Barker.
The ASIC commissioner’s comments, she says, “were notable because he referenced opinion from Noel Hutley SC [that directors who fail to consider the impact of climate change risks could be held liable] as ‘unremarkable’.”
Disclosure on climate risk
The movement for greater disclosure as it relates to climate risk took hold with the appointment by Financial Stability Board (FSB) chairman and Bank of England governor Michael Carney of Michael Bloomberg to chair the Task Force on Climate-related Financial Disclosures (TCFD), which released findings in June 2017 to help identify the information investors, lenders and insurance underwriters need “to appropriately assess and price climate-related risks and opportunities”.
Barker says this is a priority for ASIC and examples such as a case against the Commonwealth Bank in August 2017 are “just the beginning. There are many more coming.”
Dr John Purcell, policy adviser for environmental, social and corporate governance at CPA Australia, agrees. “The expectation on directors related to disclosure is clear,” he says.
“If you are building a large infrastructure project in a warming world with equivalent rises in sea level and extreme weather events, you have to adequately adjust to foresee that risk.”
Internationally, he says, the big four accounting firms that signed on to the TCFD bring the issue to the heart of the accountant’s relationship with company directors.
Investor actions over climate risk
Purcell believes that warnings from APRA and ASIC are substantially matched by principles and recommendations outlined in the Australian Securities Exchange’s (ASX) Corporate Governance Council’s Principles and Recommendations (the Third Edition) as they relate to disclosures of which accountants will be aware, but, he says, “fundamentally, directors are responsible and this value cannot be undermined”.
Purcell warns of the example provided by Client Earth, a UK-based law firm working on auditor liability and support for regulation, that referred the financial statements of oil and gas exploration companies listed on the London Stock Exchange to the UK’s Financial Reporting Council, which investigated the adequacy of disclosures as they relate to material financial risks associated with climate.
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A similar action involved a claim brought against the Commonwealth Bank in the Federal Court alleging its 2016 annual report did not adequately inform investors of climate risk. The action was withdrawn, but the bank acknowledged in its 2017 annual report that climate change posed a significant long-term driver of both financial and non-financial risks.
For Barker, the question is not whether the law permits or prohibits investment in any particular sector because, she says “the law is concerned with inputs rather than outputs. Due care and diligence is all about the robust processes that are applied by directors in making their decisions. If the process is adequately robust, the decision that falls out becomes a secondary issue.”
Financial risks of climate change
Barker says there are parallels with asbestos litigation and the movement on tobacco because climate change is an issue that has been around for decades, but these parallels are less helpful because the fight against those products was purely moral – around the health outcomes.
“While it’s true to say there is a health aspect to climate change, this issue has also evolved to the point where it stands on its own as a financial risk,” adds Barker.
Nevertheless, she believes that there are positives to be found for investors and agrees with propositions put forward by Michael Bloomberg that greater levels of disclosure will provide investors with the right information – whether they are optimists or pessimists – to back their convictions with their capital. It’s the same, she says, with the prohibition on plastic bags.
“This is a move not driven by policy; it was driven by customers and investors.”
Reporting on climate change risk: accountants will be needed